I am looking through Rosenbaum & Pearl's DCF and they use the Marginal Tax rate of 38% in both the DCF even to calculate historical NOPAT. If I were doing a DCF on a company like Microsoft which had a effective tax rate of 16.5% in FY 2020, would it be incorrect to use this tax rate for the DCF and WACC? Does it make any difference which tax rate you use (marginal vs effective) if it is more of a mature company like Microsoft?
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Pretty sure you would forecast the tax rate you actually expect the company to have. If it’s historically been 16.5% on average then you shouldn’t arbitrarily use 38% (I assume the model created on R&P’s fictional company uses the old corporate tax rate anyways). Would love to hear others’ thoughts though.
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The 38% was the marginal tax rate a while back, which is why interview questions historically assumed a 40% tax rate. Nowadays, that tax rate is 20-23% for US based companies. Might be lower for a global company like MSFT
So would I just use that same 16.5% tax rate in my DCF? or should I use the new 21% corp tax rate. Also isn't the marginal tax rate different than the 21% corp tax rate (isn't this the effective tax rate?)
Effective tax rate is what they actually pay. This will differ from marginal because they could be using tax credits, have one-time losses embedded, etc. The definition of marginal tax rate is the tax $ that you would pay on the incremental $1 of income.
That new 21% tax rate applies to the US only. If they have a slightly lower effective tax rate (save any funky losses, one-time items, etc), it's probably because they have global operations, where the other countries they operate in have a lower tax rate. Read the footnotes of the 10-K and see what they say. My guess would be using the 16.5% would make more sense, as presumably that 16.5% is lower not because of one-time items, but because they do business in countries where the tax rate is naturally lower than 21%.
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